Chesapeake Battles Bondholders Over Early Redemption Price

By Michael Aneiro

Corporate bond investors should keep an eye on the battle brewing between Chesapeake Energy (CHK) and its bondholders. Barron’s and this blog have written about corporate bond call risk many times before (see here and here), where investors holding callable bonds that are trading above par value (as most bonds are these days) and above their call price (the price at which the company can force investors to redeem those bonds early) risk losses if those bonds get called.

With most bonds that price is spelled out clearly in advance, but not so with Chesapeake’s 6.775% bonds 2019, which Chesapeake wants to redeem at par value and is seeking court approval to do so. The bonds have an unusual provision that would let the company redeem them at par between Nov. 15, 2012 and March 15, 2013 – as in by today. But bondholders say the company needed (and failed) to send a redemption request 30 days ahead of time, and now needs to pay them a “make-whole premium” to redeem the bonds. Vipal Monga of the Wall Street Journal‘s CFO Journal group writes about the battle today:

Chesapeake argued that it can make the request at any time before the deadline and still pay the bonds back at par. Before proceeding with a tender, Chesapeake sought a declaratory judgment to confirm that it had the right to redeem the bonds at par and wouldn’t be forced to pay the roughly $400 million make whole, which represented the net present value of future coupon payments on the 6.775% bonds.

U.S. District Judge Paul Engelmayer late on Thursday denied Chesapeake’s request for a preliminary injunction that would have stopped the bondholders from trying to extract the make-whole premium from the company. He added that Chesapeake had played a game of “high stakes poker,” by waiting so long to announce that it wanted to redeem the bonds. “It was risky business, even by the standards of a risky industry,” he said, according to a transcript of his statements.

Judge Engelmayer said the language in the bond contracts was ambiguous, but slightly favored the bondholders over the question of the deadline because Chesapeake had tried to clarify the issue in early drafts of the bond prospectus. That clarification language didn’t make it into the final document, suggesting it had been rejected, the judge said. He added that more evidence could come out during discovery in a full lawsuit.

Naturally, this is all hurting this particular Chesapeake’s bond issue, which is down 4.5 cents on the dollar Friday to 103.25, according to online bond trading platform MarketAxess, and is by far the most actively junk bond issue on the day.